There are many optimists on the market these days. Everything seems logical. Vaccination spells the end of the Covid-19 pandemic. And that means that the lockdowns will be lifted and the recession will come to an end. Then there’s the soft monetary policy pursued by the Fed and other global central banks. Fundamental analysts expect to see plenty of upside in the US stock market because of low interest rates and the expansion of nominal GDP. Shares trade in nominal terms and the low discount rate automatically increases the fair value of shares in DCF models. However, conventional wisdom says that what goes up must come down. But is it really going to happen?
Question: What is a fair P/E level? Aside from Lady Luck, nobody else knows the answer. But let's look at the issue from a different angle. As we know, fundamental analysis is an academic exercise. Stocks go up if and only if they are bought, and go down if and only if they are sold. In December, the volume of margin debt soared to an all-time high of $ 778 bln, up a whopping $56 bln in that month alone. This was the second largest monthly spike in history, with the record having been set in November 2020 at $63 bln. By the same token, if the market slows down, leveraged positions will very quickly play in the opposite direction. The risk of a collapse in the US stock market is actually quite high. And if this happens, the markets of other countries will quickly catch up with it.